Could the USD stage a comeback?

May 3, 2018

Charles St-Arnaud

Senior Investment Strategist

Jamie Salt

Analyst

Salman Ahmed, PhD

Chief Investment Strategist

The US Dollar is a worthy target for investor attention, given the key role it plays in financial markets and global trade. Following a prolonged period of depreciation, the USD has strengthened in recent weeks. Is this the sign of a sustained shift taking hold? And should investors be concerned over a strengthening dollar?

We believe that disquiet over the direction of US trade and fiscal policy was a key driving force that pushed the USD lower last year by reducing foreign demand for the currency and US Treasuries, alike. Moreover, the prohibitively high cost of hedging investments in US Treasuries rendered the yields unattractive for foreigners, creating a double whammy effect, in our view.

With investors' concerns now seemingly abating, and US economic growth once again appearing to outpace that of other countries, demand for both the USD and US Treasuries could see a sustained rise, especially if foreign investors become more willing to invest on an unhedged basis. Moreover, any appreciation in the USD could be amplified by a reversal of the current large short USD position in the market. As an appreciation of the USD could act as a drag on global growth and push inflation higher, how concerned should investors be?

In the medium term, we believe that concerns regarding the expansionary US fiscal policy coupled with increased US Treasury issuance will continue to put downward pressure on the USD. We would also be surprised if the US administration allowed a sustained appreciation to persist.

While the current USD dynamics are a headwind for EM assets in the short-term, we expect that reasonable valuations, supportive growth dynamics and underlying search for yield will re-assert itself, once the positioning-led greenback correction runs its course.

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